Comments on the Commission Communication [COM(2009) 561/4]: An EU framework for Cross-Border Crisis Management in the Banking Sector
Norges Bank's letter of 20 Januar 2010 to The European Commission, DG Internal Market and Services
The financial crisis has illustrated the shortcomings of the current crisis management frameworks in Europe. Inadequate tool kits for crisis resolution at the domestic level and a strong tendency to favor national solutions, including ring-fencing, in cross-border banking crises have led to uncoordinated crisis resolutions and large levels of public financial support to the banking sector. There is now a broad agreement on the urgent need for reform and the EU Communication and related staff working document is therefore to be welcomed. Since all EU banking legislation is implemented in full in Norway as an EEA member state, Norges Bank has the following comments on the Communication.
We welcome the broad approach adopted by the Commission to crisis management policy.
We note that crisis management policy has to be viewed as an integral part of the ongoing reform process related to capital and liquidity regulation.
We observed during the recent crisis that even solvent banks got into severe liquidity problems; thus a new crisis management framework cannot build exclusively on solvency levels as triggers for policy intervention.
We realised during the recent crisis the importance of vital banking services for the public and this has implications for our future systemic risk assessments.
We note that well designed deposit insurance systems capable of rapid payouts of guaranteed deposits are an integral part of a credible crisis management framework.
We suggest that a reformed framework for crisis management must be time-critical and allow for quick responses to emerging crisis situations (sometimes even on the same day).
We strongly support crisis management policies that hold shareholders, managers and, where appropriate, other creditors accountable while protecting depositors.
We support a stronger role for innovative capital and crisis intervention tools without public financial support; this will at the same time minimize the need for burden sharing among national fiscal authorities in Europe.
Early intervention tools
Which additional tools should supervisors have in order to address developing problems?
How should their use be triggered?
How important are wind-down plans ("living wills") as a tool for crisis management?
The current crisis has highlighted the importance of early intervention: Prevention is better than resolution. However, intervention powers and tools differ significantly among EU countries, as documented by CEBS. In addition, widely different national practices on regulatory adjustments to capital complicate convergence on trigger points for intervention.
As the communication rightly notes, the transition from early intervention to resolution measures can be fluid, and early intervention policies may therefore take on resolution features if for example authorities are facing sudden liquidity problems in a stressed bank. Despite this difficulty, it is important to work towards a common minimum set of early intervention tools among all EU countries. A common set of intervention tools should be available to all EEA supervisors at certain predefined stages of early stress, and these tools should if required be applicable without shareholder consent.
The new Basel proposal for a “capital conservation rule” could be a starting point for developing such early intervention triggers in the EU.  If implemented, this will introduce some elements of “prompt corrective action” in the European crisis management system, while preserving supervisory discretionary powers.
“Living wills” are, in our view, also an essential element of the new EU crisis management framework. All cross-border banks should be required to have one in place, not only the largest ones. That way, one would also avoid having to decide which cross-border banks are large (systemic) and which are not. For small banks with uncomplicated structures setting up a living will involve minor costs. Living wills would be an important part of a “cross-border license” for banks, covering issues such as legal structures, IT infrastructure, and capital and liquidity buffers.
The Financial Stability Board has recently pointed out that such contingency plans for banks actually need two distinct components. A recovery plan for maintaining a going concern and a resolution plan for institutions that needs to be closed. These two should be developed and discussed proactively with senior management of all cross-border banks. All banks should also be required to provide detailed plans for how “end of day” accounting information can be provided in case of a crisis, including key deposit information on a “single customer view”.
To facilitate recovery and resolution it may also be necessary to reduce the complexity and interconnectedness of group structures, if these are found to be too complex. In Norway, we have for long favored a holding company approach to financial institutions and as a result most of our financial groups have fairly transparent organisational structures.
Having supervisory authorities and central banks in different countries working closely with the relevant institution on these plans should improve the conditions for fruitful cooperation during a crisis, as well as the possibilities for ex ante restructuring of complex institutions that could pave the way for improved crisis management.
Intra-group asset transfers
Is the development of a framework for asset transfer feasible? If so, what challenges would need to be addressed?
What safeguards for shareholders and creditors are needed?
Cross-border banks have long requested a more flexible regulatory approach to asset transfer to improve their liquidity management and avoid “pools of trapped liquidity”. The crisis has shown that many large banks had too low buffers of both capital and liquidity, and the review of asset transfer policies in the EU should therefore support the efforts by the Basel Committee to strengthen liquidity buffers, especially in large systemic banks, on both a consolidated and solo basis.
Since asset transfer issues are also closely related to the discussion of “ring fencing”, “burden sharing” and “group support”, these should ideally be discussed together. The reluctance of some host countries to support a more flexible regime for asset transfers is closely related to their legitimate concern about transfers of assets at undervalued prices during or just prior to a financial crisis in the banking group. This is a particularly contentious issue for cross-border banking groups with business like organisations. Sorting out the responsibilities for such cross-border EU groups is therefore a precondition for any new framework for asset transfers.
The Communication (and the staff paper) suggest that asset transfers could be acceptable prior to insolvency and outside of resolution under certain circumstances. It notes that asset transfers on commercial terms takes place within all banking groups as part of their regular liquidity management. When a crisis emerges, the distinction between pre-insolvency and insolvency is, however, difficult to draw, and there is a distinct possibility that creditors may challenge any asset transfer taking place in such situations. This could prevent intra-group asset transfers that might be in the best interest of the banking group. As the Communication suggests, a possible solution could be stronger “group assurances” from the parent bank (and home authorities) as a pre-condition for such asset transfers. The alternative would be a transformation of the group to either a branch-based or a real subsidiary-based structure (see section on burden sharing below for further comments on the concept of “group support”).
Why is EU action on bank resolution needed?
What should be the key objectives and priorities for an EU bank resolution framework?
All national authorities should have a crisis management framework in place to deal with failing financial institutions, preferably a resolution system that holds shareholders, managers and, where appropriate, other creditors accountable while protecting depositors and preserving continued access to vital banking services. The recent crisis exposed the EU’s lack of an effective resolution framework, despite the recently agreed Memorandum of Understanding on crisis management.
To achieve a common banking market the EU needs a common framework for cross-border crisis management. If private sector participants know that the tool kit is not suited for time critical interventions; they will expect to be bailed out and gamble for resurrection when facing difficulties. This will leave the authorities with few other options than funding the failing bank on an “open institution” basis using public finances.
Action is therefore needed on three fronts:
- Improve insolvency regimes in all EU states to enable quick closure of small failing banks (not necessarily full harmonization)
- Establish more robust resolution regimes for larger (predominantly national) banks and cross-border banks with branch structures.
- Add a new crisis management framework specifically for cross border banking groups with subsidiary structures.
Since continuity of vital banking services and preservation of financial stability should be key concerns in a reformed EU crisis management framework, the framework need to be based on broad public policy objectives intended to preserve public confidence rather than narrow insolvency objectives.
What resolution tools are needed?
What are the key tools for an EU resolution regime?
All EEA authorities should as a minimum have a resolution toolkit available to
- split and transfer assets,
- establish a bridge bank to secure essential banking services,
- seize and run a bank (temporary public ownership).
The above resolution tools should be triggered at similar thresholds (across the EEA) and be clearly distinguished from reconstruction measures that would be applied earlier (as part of the early intervention tool kit). Resolution tools will be implemented once a bank has failed and the license withdrawn; reconstruction measures will be implemented while the bank is still (legally) open. 
It is important to ensure that national authorities have sufficient “degree of control” to implement all of the above (minimum) tools in order to preserve vital banking services. Specifically, authorities need to be able to impose these resolution measures without shareholder approval.
Some clarity is also required regarding the various national systems of public administration, conservatorship, official administration in the EU that aim to ensure public control and preserve continuity of essential banking services, but may actually lead the crisis bank to a sudden stop. It is in this regard important to determine which legal changes are required to enable resolved banks to continue vital operations. 
Threshold conditions and timing for use of tools
What are the appropriate thresholds for the use of resolution tools?
Resolution tools can be activated either based on a discretionary judgment (UK FSA threshold conditions) or based on hard (solvency) triggers (US FDIC). A resolution system based exclusively on solvency levels as triggers may not be sufficiently robust to valuation issues in a crisis. A more broad based system, with some discretionary elements may therefore be the best option in the EU. However, the system should also include some clear minimum thresholds leading to prompt resolution well before the bank is balance sheet insolvent. 
It is also important to connect the discussion about thresholds for resolution to the ongoing discussion in the Basel Committee on the appropriate level and quality of capital and the loss absorption capacity of the different capital categories. Currently, many supervisors would intervene if regulatory capital falls below 8 %, while others will not have the legal capacity to intervene before the bank is balance sheet insolvent. In Norway, authorities were given strong intervention powers after the banking crisis in the early 90s, including the power to write down share capital and subordinated loans on a going concern basis.
An additional problem area exposed by the current crisis is the widely divergent parameters used by certain IRB banks for similar credit categories. Comparison of financial strength across firms is thereby distorted, and trigger point information for supervisors weakened. The current impact assessment of Tier 1 capital has further strengthened the impression of widely divergent quality of core capital among large cross-border banks.
This regulatory limbo is detrimental to any coordinated crisis resolution and should be addressed as a matter of priority. A first step could be to clarify national differences in the EU, and then to look for common approaches to intervention within existing legal mandates. Thereafter, new legal tools could be implemented by those authorities with weak tool kits. The proposed BCBS measures on international standards for capital levels and quality should in any case facilitate a more consistent approach to resolution measures. 
The new thresholds for resolution should enable the authorities to resolve a bank with severe liquidity problems, even if regulatory capital is above the required minimum. Similar intervention threshold may also facilitate coordinated crisis intervention in cross-border banking groups.
Given the uncertainties regarding the crisis management framework for cross border banks, intervention thresholds should ideally kick in earlier for these banks than for pure domestic banks. They should also be required to hold ample buffers commensurate with the increased risk related to such groups.
Scope of the bank resolution framework
What should be the scope of an EU resolution framework? Should it only focus on deposit-taking banks (as opposed to any other regulated financial institution)?
If so, should it apply only to cross-border banking groups or should it also encompass single entities which only operate cross-border through branches?
Full harmonization of national resolution and insolvency laws will probably not be feasible in the short run, even though all national insolvency laws should be required to incorporate certain key minimum features.
We do not favour a special crisis management framework for (only) systemic banks.
Stakeholders' rights in bank resolution procedures
Is it necessary to derogate from certain of the requirements imposed by the EU Company Law Directives, and if so which conditions or triggers should apply to any such derogation? What appropriate safeguards, review or compensation mechanisms for shareholders, creditors and counterparties would be appropriate?
Adjustments need to be made to relevant EU legislation to enable authorities to implement the new resolution regime, while at the same time preserving shareholders rights (according the ECHR). However, we strongly hold that authorities should have the power to intervene early to preserve vital public interests if private shareholders cannot support a failing bank. When the share capital have been more or less lost, shareholder should be given a fair chance to participate in a recapitalisation, but failing this, authorities must be in a position to intervene without shareholders’ approval.
The new crisis management framework will therefore have to be based on explicit broad objectives that preserve vital payment services and protect financial stability. The objectives and safeguards in the new UK Special Resolution Regime should be used as a reference.
Application of resolution measures to a banking group
How can cooperation and communication between authorities and administrators responsible for the resolution and insolvency of a cross border banking group be improved?
Is integrated resolution through a European Resolution Authority for banking groups desirable and feasible?
If this option is not considered feasible, what minimum national resolution measures for a cross-border banking group are necessary?
Crisis coordination between national authorities will be greatly facilitated if all EU countries have a common minimum tool kit in place. This is particularly the case for large subsidiary based financial groups, where resolution must be based on separate legal entities. Closer cooperation in supervisory colleges and more frequent interactions of key policy makers is needed to provide a more solid ground for crisis resolution among such firms.
Large cross-border banking groups with branch based organizations should normally be resolved under the universal approach, i.e. a resolution that provide for uniform measures and mutual recognition of measures across borders. However, as the Icelandic case showed, if the parent banks have outgrown the local supervisory and deposit insurance systems, there is a legitimate basis for host county intervention to protect national interests. We support greater scrutiny of home country regimes in the future, and a due process allowing host supervisors to raise their concerns. Parent banks must not be allowed to outgrow their home base, i.e. the national capacity to supervise and support overseas commitments.
Large cross-border banking groups with business line organization, but with legal subsidiary structure, pose a special challenge for crisis resolution, as noted in the Communication. Host authorities may have reservations about supporting such “quasi subsidiaries”, and may not even be able to ring fence them since their liquidity, funding and IT functions have been centralized to profit centers in another country. This can easily create a stand-off situation between the home and the host authorities. Two possible solutions should be explored: One would be to disregard their (legal) separate entity structure and treat them as though assets and liabilities were held by a single corporate entity (“pierce the corporate veil”) and base responsibilities on the actual operations of the group, i.e. the parent banks should be asked to confirm their support for subsidiaries and home authorities’ responsibilities should likewise reflect the corporate reality. The alternative solution would be to ask the banking group to bring the legal structure more in line with the business line structure, i.e. to transform to a branch based organisation. If this is not acceptable to the group, the host authority should be allowed to impose conditions on the local subsidiary to enable national crisis resolution.
Clarifying the responsibilities for cross-border banking groups with business line organization is in our view key to further progress on cross-border crisis resolution in the EU.
Financing a cross-border resolution
What is the most appropriate way to secure cross-border funding for bank resolution measures?
What role is there for specific private sector funding?
Is establishing ex-ante crisis funding arrangements practical? If not, how could private sector solutions best address the issue? Is there scope to achieve greater clarity on burden sharing? If so, would the first priority be to define principles for burden sharing?
Close coordination of regulatory and supervisory standards between countries sharing a banking group will obviously reduce potential conflicts of interest. If bank operations in each country have been established based on rules and standards agreed between individual supervisors, it will also be politically more acceptable to shoulder a part of the burden in cases where banks run into trouble.
Private sector funding should always be the preferred way to secure funding for bank resolution in the EEA. This goes beyond simply writing down shareholder capital and removing management of failing institutions. A renewed framework for crisis management in the EU should be able to liquidate smaller bank quickly and resolve larger banks smoothly without disrupting vital banking services to the public. Deposit insurance schemes should also be allowed to contribute to such private based crisis resolutions.
The challenge will be to prevent and resolve banking crisis in the largest banks. As a preventive measure, we believe cross-border banks should be required to hold ample capital and liquidity buffers. The large negative real economy effects of a potential disorderly resolution process for a large cross-border bank represent a negative externality that should be appropriately captured in the incentives facing such banks. This is indeed the direction of current regulatory initiatives, which we strongly support. This could take the form of a systemic surcharge to the national deposit insurance fund, or as an extra capital charge, probably under Pillar 2. This surcharge could be lowered if the complexity of the group is reduced, for example following a review of a resolution and recovery plan. In addition, we support ongoing work that explores various ways of spreading the cost of bank resolutions among shareholders and unsecured creditors, for example through the use of contingent capital instruments or debt-for-equity swaps.
Increasing the scope for private sector solutions should reduce the need for fiscal burden sharing among host and home authorities. Agreement of burden sharing principles (of resolution costs among affected national authorities) should therefore not be seen as a precondition for improved crisis management in Europe.  In our view, priority should be given to improving national crisis resolution and insolvency systems and requesting cross-border banks to develop recovery and resolution plans. Also, national deposit insurance systems need to be much improved to be able to handle smaller banking crisis and provide quick payouts of guaranteed deposits.
Any discussion on burden sharing among authorities hosting banking subsidiaries that are part of a banking group organized along business lines will in any case be quite difficult, especially since the host authorities have a limited role in influencing the business of the local bank. It is worthwhile to explore further what can be achieved through an approach based on “group support” and “piercing the corporate veil”, as noted in the Communication. The parent bank could be requested to provide “support statements” for the host banks (letter of comfort, contribution orders, etc.). If the parent bank is unwilling to provide such assurances, the host authority should be allowed to require the bank to adapt its organization to the legal reality, i.e. reduce branch-like-features of the subsidiaries. This should clearly be considered a last option.
A harmonised EU insolvency regime for banks
Is a more integrated insolvency framework for banking groups needed? If so, how should it be designed?
Should there be a separate and self contained insolvency regime for cross-border banks?
A fully harmonized insolvency regime in the EU may not be feasible in the short run. A minimum harmonization of national insolvency and resolution regimes should be attempted, focusing on a few critical features that all national regimes should incorporate.
Additional minimum requirement for banks wishing to conduct cross-border business in Europe should then be enacted, on a national level and with supplementary powers to the new European Banking Authority.
As noted above, clarifying responsibilities for resolving complex corporate structures where form does not follow function should be a priority.
Thorvald Grung Moe
- The proposed rule will reduce the discretion of banks which have depleted their capital buffers, see. pp. 68-69 of the December Consultative Document: Strengthening the resilience of the banking sector by the BCBS.
- We therefore consider the “resolution policies” discussed in the staff WP for Italy and Spain (on pp. 27-28) to be closer to early intervention measures and open bank assistance; i.e. the terminology should be standardised.
- Ref. US legislation enabling the FDIC to set up bridge banks and preserve derivative contracts without operational interruption.
- The challenge will be to reconcile interventions based solely on a breach of the (current) regulatory minimum capital level with shareholder’s rights at such relatively high capital levels. If the bank is considered long term viable, regulatory forbearance may be warranted (i.e. give the bank owners some time to restore the capital). However, if the bank is facing severe liquidity problems, this may not be a viable option, and authorities should then have the legal power to close the bank quickly and postpone the determination of residual value.
- Currently a breach of either the 4% or the 8 % minimum capital level will imply widely different real intervention levels in different EU countries due to regulatory adjustments to the minimum capital.
- Ref. statement on p. 8 in the Communication that … the existence of adequate, fair and legally compliant burden sharing arrangement … is critical for any agreement to limit the right of Member States to ring fence local assets.